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Canada: Canada clarifies foreign currency conversions for thin-cap ratio


Nancy Diep

Canada's thin-capitalisation rules operate to deny all or part of an interest expense in Canada for a taxation year if the amount of the interest-bearing debt owing by a borrower to specified non-residents (that is, persons who hold – or do not deal at arm's-length with persons that hold – 25% or more of the applicable votes or value of the borrower) exceeds the borrower's equity by more than a 1.5:1 ratio. Any excess interest that is not deductible for a taxation year is also treated as a deemed dividend subject to Canadian withholding tax.

In computing the ratio for a taxation year, outstanding debts to specified non-residents is equal to the monthly average of the greatest total amount owing at any time in the month to specified non-residents. There has been considerable uncertainty regarding the computation of the ratio where outstanding debts are denominated in a non-Canadian currency. This uncertainty is largely attributable to the Canada Revenue Agency's historical view that any non-Canadian dollar denominated debts owing to specified non-residents had to be converted to Canadian dollars on each calculation date; a position which could result in unexpected application of the thin-capitalisation rules.

Since those earlier statements, the Income Tax Act (Canada) was amended in 2007 to introduce new functional currency conversion rules. In particular, subsection 261(2), which is actually effective for all taxation years, requires any amount relevant to determining a taxpayer's Canadian tax results that is expressed in foreign currency to be converted to Canadian currency using the relevant spot rate on the day that the particular event arose. Consequently, the agency was asked at the most recent Canadian Tax Foundation conference (on November 24 2015) to update its original position.

In response to a question about whether taxpayers should use the foreign exchange rate on the date a debt was issued or on each calculation date, the agency indicated that it now regards the issue date for a foreign currency debt to be the applicable date for the purposes of computing the ratio. This position should remove the need to re-determine the amount of the debt at each calculation date, as well as the possibility that the amount would change because of future foreign exchange fluctuations.

Nancy Diep (, Calgary

Blake, Cassels & Graydon

Tel: +1 403 260 9779


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